“There are several factors accelerating the asset class’s growth, however the most prominent considerations for investors are typically the potential for enhanced yields, portfolio diversification, and the greater downside protection offered by private credit versus public fixed income investments,” says Marti.

However, something that not all investors realise is that the global private credit market actually encompasses a host of different asset classes. Senior corporate lending, subordinated corporate lending including mezzanine and second lien debt, infrastructure debt, real estate debt, and asset-backed lending all fall under the private credit umbrella.

And there’s one primary reason an investor would embrace private credit in today’s economic environment – to minimise volatility.

“Private credit performance is quite different than what we typically see in the public markets,” says Marti.

“The public markets have supply and demand technicals that can lead to much more volatility in loan prices, whereas in the private market the loan valuations are a true reflection of the actual credit worthiness of the borrower. You don’t have that market sentiment volatility, or supply demand imbalances, that can cause fluctuations in loan prices.”

In terms of where it fits into an investor’s portfolio, private credit is a natural complement to other fixed income investments. And this is for several reasons.

First and foremost, Marti says, most private credit investments are floating rate, so they provide protection against rising interest rates. In addition, private credit has very low correlation to other asset classes including high yield bonds, corporates and treasuries.

“And finally, risk adjusted returns. Average yields in private credit have exceeded those in both broadly syndicated loans and high yield bonds. Further, these are income producing assets and, generally, they’re going to pay income into the fund on a quarterly or monthly basis,” Marti says.

Despite the boom in private credit activity, many investors may also not be aware of how managers actually source the underlying assets for private credit strategies. Marti says there’s a plethora of ways this can be done - it really depends on the kind of opportunities they’re interested in.

For example, a non-sponsor-backed opportunity would be sourced by an intermediary such as an investment bank, while sponsor-backed opportunities are generally sourced directly from private equity firms.

As for identifying opportunities, as Marti says, the private credit world is often referred to as “middle market” and there are three distinct segments of the middle market. These are the lower middle market, the core middle market, and the upper middle market.

“The lower middle market is generally going to include businesses generating less than US$15million in earnings before interest, taxes, depreciation, and amortisation (EBITDA). The traditional or core middle market would include businesses generating $US15-$75 million of EBITDA, and then the upper middle market would include those larger businesses generating above $75 million of EBITDA,” Marti says.

“And asset managers can seek to deploy capital into any of these market segments.”

Marti, who has more than three decades’ experience investing in private markets, says each asset manager’s approach to sourcing deals is unique. In fact, it’s probably one of the most important considerations for an investor when assessing a manager.

Why?

“If you don’t have a strong sourcing mechanism you’re not going to have that consistent deal flow and the ability to be very selective in the opportunities that you choose,” she says.

“Another important differentiator is track record - you want to make sure that that asset manager has a long term track record of investing in the private credit market through multiple market cycles.”

Importantly, don’t be afraid to ask the uncomfortable questions. Ask specific questions around their loss history, default rates, and other key pieces of intel that a manager may not be forthcoming about.

“These are very important topics as you’re assessing a private credit manager, and another thing would be their scale. Are they able to lead transactions and hold the pen in the documentation and lead that negotiation? Or are they simply a participant, just investing smaller dollars in a transaction, not really having that lead role in a transaction?” she says.

The final element Marti says is crucial to consider before signing on any dotted lines is a discussion around workout capabilities.

“Private credit asset managers do a great job of selecting assets, but not every single asset is going to perform as you expected,” she says.

“And having a strong workout team and having those workout capabilities to deal with more troubled situations is very important.”

The IMF’s 2024 Global Financial Stability Report says private credit sector, says the asset class primarily serves middle-market firms that do not have access to traditional bank lending or public debt markets.

Private credit has shown resilience during times of economic distress. The report notes that during the COVID-19 pandemic, “private credit lending did not ‘dry up’, while high-yield bond and leveraged-loan issuance contracted strongly.”

“Private credit lending subsequently proved more stable than similarly floating rate leveraged loans.”

To mitigate risks in the sector, the IMF recommends stronger regulatory oversight and enhanced transparency, the report says.

“Given the potential risk private credit poses to financial stability, authorities could consider a more proactive supervisory and regulatory approach to this fast-growing, interconnected asset class.”

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